How to Save with Coverdell Education Savings Accounts

Those who want more investment choices may want to consider Coverdell Education Saving Accounts (ESA). A Coverdell ESA is a trust or custodial account created or organized in the United States only for the purpose of paying the qualified education expenses of the designated beneficiary of the account.

Formerly known as an Education IRA, ESA's are another tax-advantaged way to pay for college. Unlike 529 plans, your investment options are virtually limitless. Except for investing in life insurance contracts, you can buy and sell what you want whenever you want. Also, you can set them up at almost any brokerage firm, mutual-fund company, or other financial institution.

Federal Tax Advantages Earnings in ESA's are tax-deferred, and withdrawals that are used for qualified education expenses are tax-free.

Education Expenses Covered One advantage that ESA's have over other tax-advantaged saving options is that you can make tax-free withdrawals to pay for private elementary and high school expenses, as well as post-secondary school expenses. So if a private school is in the future, one option you might want to consider is saving for that expense in an ESA and using a 529 plan for college.

Contribution Limits of Coverdell Education Savings Accounts

ESA's have two annual contribution limits for individuals:

You can give up to $2,000 per year until child is 18 (unless the child is special needs), assuming you meet the ESA income limits discussed below.

The total of all contributions to all ESA's set up for one beneficiary cannot exceed $2,000 per student. If other family members set up ESA's for your child, you need to check with them to make sure this contribution limit is not exceeded.

If you exceed these contribution limits, there is an excise tax on excess contributions. If you have a loss on your investment in a Coverdell ESA, you may be able to deduct the loss on your income tax return. You can deduct the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. Your basis is the total amount of contributions to that Coverdell ESA.

A "responsible person" controls the account until the beneficiary reaches "the age of majority" (age 18 in most states). The person in control of the account chooses the investments, which can be stocks, bonds, mutual funds, or cash equivalents.

There are contribution limits if your modified adjusted gross income (MAGI) is more than $110,000 ($220,000 if filing a joint return), that would limit the contribution amount to $1000 or if you exceed the income limit $0. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return. There is no limit on the number of separate Coverdell ESA's that can be established for a designated beneficiary, and if you exceed income limits children can open their own accounts. However, total contributions for the beneficiary in any year cannot be more than $2,000, no matter how many accounts have been established. Organizations, such as corporations, can also contribute to ESA's and are not subject to any income limits.

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